Book Review: 'The Greatest Trade Ever'

by: optionMONSTER

By David Russell

One of the biggest attractions of trading for most people is the amount of money that they (think) they can make. And the stories of others' success drive that desire to greater levels. We hear the stories of people turning $10,000 into $1 million, and we are emboldened to think we can do the same.

So Gregory Zuckerman's The Greatest Trade Ever is a mixed blessing. Obviously I am still playing catch up in my reading, and have probably come to this one after many of you. If you haven't read this book yet, you should.

It tells the story not only of the greatest trading profits ever earned, but also the greatest option trade ever. For while the derivatives used by John Paulson and his associates were not strictly options, they were essentially buying puts on mortgage securities.

They also had to overcome major barriers to succeed. For example, Paulson started his now-huge fund with $2 million of his own money because he couldn't find any investors.

And these individuals weren't established derivatives traders. Paulson was a merger-arbitrage specialist, while Michael Burry was a value investor. Nonetheless, they were able to identify and buy the cheapest puts ever, given what was necessary for them to pay off.

Zuckerman also highlights the difference between positive and negative carry trades. Institutional investors usually dislike negative carry trades because they cost money on a regular basis. They're more interested in keeping up with their peers, and think they can't afford a position that will hinder their short-term performance. They do like positive carry trades, so much so that many of the "smartest guys in the room" were willing to sell protection to Paulson. They took a little of his money in the beginning, and he took all of their money -- and plenty more -- when the mortgage bubble broke.

This provides a lesson for option traders. While it is often profitable to use positive carry trades, like writing options, you must understand the value of what you are selling. You are providing someone else with insurance, and you have to appreciate the circumstances under which you will be obligated to pay them. After all, you might be up against the next John Paulson.